There's been talk that the silver lining for the Japanese earthquake/tsunami disaster was an economic resurgence. But this is short-term, one-dimensional thinking.

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The human tragedy is still unfolding but there was already talk on Friday that the silver lining for the Japanese earthquake/tsunami disaster was an economic resurgence. I suppose it was to be expected given the dire circumstances. PIMCO's Mohamed El-Erian further crystallized it by explaining that there would be short-term dislocations for the Japanese economy followed by a sharp rise in GDP from rebuilding. Unfortunately, it appears that the "broken window fallacy" is alive and well.

French economist Frederic Bastiat widely publicized this parable of logical ineptitude. For Bastiat, a broken window at a baker's shop did not, contrary to growing acceptance, constitute economic progress. It was true that the baker had to find and hire a glazer to repair his window, but it was money that would come at the expense of other goods and services the baker would have spent elsewhere. In fact, the broken window actually made the economy poorer in the aggregate (in terms of real wealth).

If we extend this parable to the Japanese earthquake, Mr. El-Erian is saying that the destruction will be beneficial in the long run because money will flow and create activity where there was none before. As long as the monetary flow is employing labor and materials it can be seen as a positive.

This line of thinking is entirely one-dimensional in that it only considers the flow of capital. For El-Erian, it is perfectly acceptable that the Japanese government will be the source of the flow. It is even acceptable that the Bank of Japan (the Japanese version of a central bank) will create new yen to help offset the burden of monetary flow upon the Japanese government. In this one-dimensional argument all that matters is that money is flowing to labor and material.

What is missing is the real idea of wealth and economy. An economy is not simply flowing currency from one subset of holders to another, though that is the way it is predominantly measured. Wealth is not a finite amount of flowing currency, nor is it a measurable quantity of currency. Wealth, for all practical purposes, is the productive capacity of a nation or subset.

That productive capacity is the rightful source of monetary flow in a truly functioning, non-distorted economy. If a business is doing well enough that it needs to expand or buy new, more efficient capital equipment, then that is a sound fundamental basis for economic flow, i.e., GDP. If that business sees a factory destroyed by fire and the need to rebuild is the source of monetary flow, then the overall economy is poorer because scarce materials and productive labor have to be used to create what was already in place.

If destructive power was positive for an economy, then why is there no national effort to get US workers employed by destroying buildings one day and rebuilding them the next? The answer is that the source of funds from such a process would be a subtraction from the stock of wealth. In other words, to pay for the building to be destroyed and rebuilt continuously the owner would have to draw down its savings since there is no new productive capacity created by these flows.

When a commercial building is destroyed by fire or natural disaster, the owner becomes poorer during the rebuilding process since that owner has to subtract from personal assets (or insurance assets) to recreate what was once productive. That subtraction overwhelms any positive contribution from the flow of assets to the workers that rebuild the building. In fact, because that flow is only temporary, the entire process is a net loss to the aggregate economy.

It does not matter if the source of monetary flow is pre-existing assets or if it is newly created through money printing. In the latter case, the central bank is nationalizing the loss away from the individual owner, but the aggregate economy is actually worse off for it.

Since currency is simply a claim against assets, after rebuilding there will be a lot more claims on an asset base that will, at best, be close to what it was before the disaster. More claims on an unchanged productive base mean a poorer economy. I am sure some will make the argument that overall productive capacity will grow since the rebuilt structures and businesses will be newer and likely more efficient, but that will simply be subtracted by a greater cost to the rebuilding efforts. Should we expect that the Japanese government would create new capacity at the replacement value of the old?

Finally, adding another dimension to this discussion is the lost marketplace for existing businesses. It does not follow that Honda (HMC) or Toyota (TM) will be better off now. They may experience some increase in demand because so many of their customers' vehicles have been destroyed. That may be a small positive in terms of immediate demand but it is more than balanced by a lack of functioning infrastructure and opportunity cost.

With port capacity diminished, Honda, Toyota, Sony (SNE), or any number of high tech manufacturers will have trouble shipping their products (let alone getting them to the ports, or even getting them made while electricity is in short supply) in the months ahead. The global marketplace will not sit and wait for them to catch up. Demand will simply flow to competitors or alternate products.

Believing that this disaster can be positive for Japan is short-term, one-dimensional thinking. The picture is far more complex than simply monetary flows for rebuilding. The entire stock of wealth in Japan is now significantly reduced. Rebuilding will only try to return the nation to its previous level, but with many more liabilities attached. And while that plays out Japanese businesses fall prey to global competition and lost opportunities.

This has been a human tragedy in so many ways, and the coming economic toll only makes it worse.

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